Skip to Content
MarketWatch

A drop in Social Security's Average Wage Index could hurt four million people

By Alicia H. Munnell

Fortunately, legislators are already proposing fixes

I understand that not everyone savors, with as much enthusiasm as I do, testimony by Steve Goss, Social Security's chief actuary. But I always find it very helpful.

His most recent appearance before the House Ways and Means Subcommittee on Social Security touched on a number of ways that COVID-19 might affect the program (link) and clarified the implications of a drop in the Average Wage Index (AWI) and how proposed legislation might address the problem.

The 2020 Trustees Report (link) projected that the AWI, which equals total wages in the year divided by the number of wage earners, would increase by 3.5% from 2019 to 2020. But, in the wake of COVID-19, the Average Wage Index in 2020 is likely to decline rather than increase.

Read: Today's older workers may see the first cuts to Social Security benefits (link)

As a result, those born in 1960 (who turn 60 in 2020) could see a permanent cut in their benefits. The problem arises because past earnings and the benefit formula are adjusted by Social Security's AWI.

More specifically, benefits are calculated in two steps. The first step is determining the worker's Average Indexed Monthly Earnings, which involves adjusting nominal earnings for each year up to age 60 by the AWI and identifying the highest 35 years for calculating the average. To the extent that the AWI declines, average monthly indexed benefits will be lower.

The second step involves calculating the Primary Insurance Amount -- the benefit payable at the Full Retirement Age of 67 -- by applying Social Security's progressive benefit formula to the worker's Average Indexed Monthly Earnings. The thresholds in the benefit formula are also indexed by the AWI. If the thresholds decline, workers will find more of their earnings in brackets with lower replacement rates.

So, what might happen to the AWI this year? Although no one knows for sure, experience so far in 2020 suggests that total wages will be about 10% lower than projected in the 2020 Trustees Report and the number of workers will be about 1% lower than projected. (The number of workers doesn't decline very much because AWI includes all wage earners even if they only worked for the month of January.) If these percentage declines play out, then the average wage index will be 9.1% (1 -- 90/99) lower than projected for 2020.

One more calculation is required to get at the likely change in the AWI between 2019 and 2020. As noted, the assumptions in the 2020 Trustees Report imply that the AWI in 2020 would equal 1.035 of the AWI in 2019. However, because of the pandemic, the 2020 AWI will be only 0.909 (90/99) of the projected level. Therefore, the 2020 AWI would actually equal only 0.941 (0.909 x 1.035) of the 2019 value -- a decline of 5.9%.

Assuming these declines come to pass, about four million people will receive benefits that are 9.1% less than expected or 5.9% less than benefits awarded in 2019. These reductions apply throughout the beneficiary's lifetime. This loss is meaningful.

As a result, two bills have been submitted to offset these impending losses. While legislation could restore the entire 9.1% shortfall, both focus on eliminating the 5.9% drop in the AWI from 2019 to 2020. Senators Tim Kaine (D-VA) and Bill Cassidy (R-LA) introduced the "Protecting Benefits for Retirees Act." This bill would not allow the AWI to drop from one year to the next for benefit computation purposes, but instead would use the highest previous level -- in this case the 2019 AWI.

Congressman John Larson's (D-CT) "Social Security COVID Correction and Equity Act" would also eliminate the reduction in benefits due to the drop in the AWI, but only for those who become newly eligible two years after the decline. The bill, however, also provides one-year increases for many Social Security beneficiaries and Supplemental Security Income recipients in 2020. Neither bill would have a significant effect on the actuarial status of the program.

Fascinating, right?

-Alicia H. Munnell; 415-439-6400; AskNewswires@dowjones.com

RELATED: This eye-opening experience has me re-thinking how Social Security fits into my retirement planning (link)

RELATED: New savings target for a modest retirement -- $8 million? (link)

RELATED: Life will never be the same for people over 60 -- even with a COVID-19 vaccine (link)

 

(END) Dow Jones Newswires

09-12-20 1235ET

Copyright (c) 2020 Dow Jones & Company, Inc.

Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.

We’d like to share more about how we work and what drives our day-to-day business.

We sell different types of products and services to both investment professionals and individual investors. These products and services are usually sold through license agreements or subscriptions. Our investment management business generates asset-based fees, which are calculated as a percentage of assets under management. We also sell both admissions and sponsorship packages for our investment conferences and advertising on our websites and newsletters.

How we use your information depends on the product and service that you use and your relationship with us. We may use it to:

  • Verify your identity, personalize the content you receive, or create and administer your account.
  • Provide specific products and services to you, such as portfolio management or data aggregation.
  • Develop and improve features of our offerings.
  • Gear advertisements and other marketing efforts towards your interests.

To learn more about how we handle and protect your data, visit our privacy center.

Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.

To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.

Read our editorial policy to learn more about our process.